The US Dollar Index (DXY), which measures the value of the US Dollar (USD) against six major currencies, halted its four-day winning streak and is trading around 99.00 during Asian hours on Monday.
The New York Times reported on Sunday that market caution had grown around the Federal Reserve after federal prosecutors opened a criminal investigation into Federal Reserve Chairman Jerome Powell over the renovation of the central bank’s headquarters in Washington and whether he misled Congress about the scope of the project.
The dollar faces challenges as traders evaluate the possibility of further US Federal Reserve interest rate cuts after the latest jobs report showed job growth was below expectations in December. US nonfarm payrolls rose by 50,000 in December, lower than the 56,000 in November (revised from 64,000) and weaker than market expectations of 60,000. However, the unemployment rate fell to 4.4% in December from 4.6% in November.
Richmond Fed President Tom Barkin said the lower unemployment rate was welcome and described job growth as modest but stable. Barkin added that it’s difficult to find companies outside of healthcare or artificial intelligence that are hiring, and said it’s still unclear whether the job market will tilt toward more hiring or more layoffs.
Traders continue to price in two interest rate cuts from the Federal Reserve this year, although the central bank is widely expected to keep policy unchanged later this month. According to CME Group’s FedWatch tool, Federal Reserve funds futures continue to be priced at a roughly 95% probability that the US central bank will keep interest rates unchanged at its meeting on January 27-28.
However, the US dollar may rise amid rising geopolitical tensions. US President Donald Trump warned Tehran against using force against the demonstrators and indicated possible action if the repressive campaign intensified, while Iranian officials warned against any American or Israeli intervention. Meanwhile, European countries led by the United Kingdom and Germany are considering increasing their military presence in Greenland to enhance security in the Arctic.
Frequently asked questions about the US dollar
The US dollar (USD) is the official currency of the United States of America, and the “de facto” currency of a large number of other countries where it is traded alongside local banknotes. It is the world’s most traded currency, accounting for more than 88% of total global forex trading volume, or an average of $6.6 trillion in transactions per day, according to 2022 data. After World War II, the US dollar took the place of the British pound as the world’s reserve currency. For most of its history, the US dollar was backed by gold, until the Bretton Woods Agreement in 1971 when the gold standard disappeared.
The most important factor affecting the value of the US dollar is monetary policy, which is shaped by the Federal Reserve. The Fed has two missions: achieving price stability (controlling inflation) and promoting full employment. The basic tool for achieving these two goals is adjusting interest rates. When prices rise too quickly and inflation is above the Fed’s 2% target, the Fed will raise interest rates, which helps the value of the US dollar. When the inflation rate falls below 2% or when the unemployment rate is very high, the Fed may cut interest rates, which affects the dollar.
In extreme cases, the Fed could also print more dollars and activate quantitative easing (QE). Quantitative easing is the process by which the Federal Reserve dramatically increases the flow of credit into a stuck financial system. It is a non-standard policy measure used when credit dries up because banks will not lend to each other (due to fear of the counterparty defaulting). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It has been the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis of 2008. This involves the Fed printing more dollars and using them to buy U.S. government bonds mostly from financial institutions. Quantitative easing usually leads to a weakening of the US dollar.
Quantitative tightening (QT) is the reverse process whereby the Fed stops purchasing bonds from financial institutions and does not reinvest capital from bonds it holds outstanding in new purchases. It is usually positive for the US dollar.
